Before software eats the world, it's going to have to figure out its tax status

The open-source software model -- which is increasingly dominating the IT industry -- may be founded on altruistic and community-minded intentions, but billions of dollars of revenue are now tied into it. And that's creating tax issues for its proponents and sponsors.

Photo credit: Joe McKendrick

A new report by Wired's Robert McMillan notes that many open-source software projects can't get non-profit status (and thus be exempt from taxes) status from the U.S. Internal Revenue Service (IRS) because they straddle a hazy zone between volunteer-driven projects and corporate pet projects.

Some of the industry's high-level and volunteer-intensive efforts -- in particular, the Apache Software Foundation -- is, as the name suggests, organized as a foundation and enjoys tax-free status as a nonprofit. But ultimately, the work coming out of Apache underpins some of the hottest growth industries around, such as Hadoop, the clustering solution that enables enterprises to get a handle on Big Data.

In fact, products such as Hadoop are turning the entire database industry upside down. "Open source software is about to blow up the database industry, and Hadoop is the nitroglycerin," notes Derrick Harris in a recent post at GigaOm.

Many other open-source organizations, however, are having difficulty getting classified as non-profit entities. MacMillan documents the IRS's doubts about the open-source model as it relates to corporate benefit:

"For the past four years, it’s been close to impossible to get an open source project approved for 501(c)(3) classification — a nonprofit status that allows supporters to make tax-exempt donations to the organization.... In a sense, open source software is a victim of its own success. Over the past decade, there has been an avalanche of open source software development, much of it sponsored by extremely profitable technology companies such as Google, IBM, and even Microsoft. The IRS, however, is struggling with figuring out which of these projects are true to the spirit of 501(c)(3) requirements, and which are simply there to help sell products."

Many open-source projects are even officially parts of software vendor operations, which provide the built-in advantage of professional support. For example, Oracle has acquired both Sleepycat Software (caretaker of the open-source Berkeley DB) and MySQL, caretaker of the open-source relational database of the same name.

It works in reverse as well. In other cases, open-source projects have spun out from the depths of corporations, such as the open-source Eclipse project, provider of development tools, started within IBM.

MacMillan observes that along with those projects that are corporate projects, many open-source efforts are legitimately not-for-profit and community controlled. The problem is the IRS is having a hard time distinguishing between the two.

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